Alpha Dinar- talking Gulf finance » Big Mac Index

Understanding the Currency War

Sal — Mon, 18 Oct 2010 07:12:24 +0000

Both the US and China have their flaws, be it in fiscal or social policy, yet on a relative basis I believe the U.S. is more to blame as it has been exploiting the global economic turmoil to its advantage by exporting inflation global through its weaker currency.

The best way to understand why are we even having a currency war is to understand the concept of Purchasing Power Parity, “law of one price”, which states that the exchange rate adjusts so that an identical good in two different countries has the same price when expressed in the same currency. Or simply, a Big Mac in U.S. dollars should be priced equally the same worldwide.

The Big Mac Index, published annually by The Economist, is an index that uses the US dollar as a benchmark and analyses whether other currencies are over/ undervalued relative to the U.S. dollar. Studying the table below, in China a McDonald’s Big Mac costs just 14.5 Yuan on average, the equivalent of $2.18 at market exchange rates. In America the same burger averages $3.71. That makes China’s Yuan one of the most undervalued currencies in the Big Mac index. Since 14.5 Yuan can buy the same burger that is sold for $3.71, a Yuan should be worth $0.26 on the foreign-exchange market. At just $0.15, it is undervalued by about 40%.

Weekend Edition: Again With the Big Macs

Saud — Fri, 16 Oct 2009 02:02:26 +0000

How big really is your paycheck? You can calculate it in terms of dollars, or preferably in terms of what you can actually purchase, in other words purchasing power parity. A couple of weeks ago I posted about a similar subject “Burgernomics” where different Big Mac prices in different countries value the home currency relative to the dollar. Here, a report done by UBS published in The Economist studies the number of hours an employee has to work to earn the price of a Big Mac.

Weekend Edition: Burgernomics

Saud — Thu, 17 Sep 2009 16:54:36 +0000

Purchasing Power Parity is based on the concept of the “law of one price” which states that the same goods should cost the same in different countries when you factor in the current exchange rate. This simply means that a dollar should buy the same product in every country.

If you find this concept a bit hard to consume, you will probably need the Big Mac Index.

The Economist annually publishes the Big Mac index which tracks the price of Big Macs in more than 120 countries. So, what do we learn from this index? The index uses the US dollar as a benchmark and analyzes whether other currencies are over/undervalued relative to the US dollar. Big Macs cost $3.57 in the US. According to purchasing power parity, any variation in the price of a Big Mac from $3.57 indicates that the country’s currency is either over/undervalyed. Studying the table below, a Big Mac cost less in Asia and more in Europe. This means that Chinese Yuan is undervalued and the Swiss Franc is overvalued relative to the US dollar.

It also means that you should eat a lot of Big Macs in South Africa if you ever make it to the World Cup!